Severance and Unemployment: Everything You Need to Know

With the recent trend of mass layoffs and downsizing, the unemployment floodgates have opened. If you happen to be among those being told your position or department has been reduced or dissolved, you might wonder what your next steps should be.

In most cases, when large companies have mass layoffs, the newly unemployed will be left with a couple of options. The options available depend upon what benefits your company provides as part of the layoff process. Some companies will offer a severance package to help soften the blow. Others might hand you your last paycheck and information on how to apply for unemployment benefits and COBRA insurance.

If you’ve experienced a sudden job loss, here is what you need to know.

What is severance pay?

Severance is a type of compensation that an employer may pay an employee upon termination of their employment. It is typically provided to employees who are laid off or fall victim to downsizing or company restructuring. The purpose of severance pay is to provide financial assistance to employees while they find another job or retire.

Because severance packages can be a matter of agreement between the employer and the employee, they’re usually written into your employment contract. In some cases, they might be outlined in the company’s policy.

The amount of severance pay offered is often calculated as a certain number of weeks or months of an employee’s salary. It may be provided in addition to other benefits such as unemployment insurance (UI). The specifics of what is included in a severance package can vary depending on the employer and the circumstances of the termination. Some common elements include the following:

  1. Severance pay: This is the most common component of a severance package and takes the form of direct compensation.
  2. Continuation of health insurance: Some employers will continue health insurance benefits for a certain period after an employee’s termination.
  3. Outplacement assistance: This can include career counseling, resume writing, and job search assistance to help the employee find a new job.
  4. Retirement plan and stock options: Some employers may offer to pay out the remaining balance of the employee’s retirement plan or stock options. They might also offer some other compensation for the employee’s loss of these benefits.
  5. Other benefits: Depending on the employer, a severance package may include additional benefits such as vacation pay, bonus pay, or pay for unused leave.

Does severance pay get taxed?

Severance pay is taxable income. As such, it’s subject to federal income and payroll taxes. In some cases, they might also be subject to state and local taxes. The taxes will be withheld from the severance pay at the same rate as your regular wages, based on the information provided on your W-4 form.

You will also be required to report the severance pay on your federal income tax return. As such, your employer might include it on your Form W-2, so consider checking it for accuracy before filing your taxes.

If you receive your severance pay in a lump sum, your employer may choose to withhold a flat 22% federal income tax. If your severance pay is paid out over a period of time, your employer will likely use the same withholding rate as your regular pay, which may be different. Any benefits in your severance package, such as continuing health insurance, may also be subject to taxes.

For example, the value of continuation of health insurance may be added to your taxable income and subject to taxes. You should consult with a tax professional or the IRS if you have any questions regarding your taxes and the severance package you received.

How does a severance affect my retirement?

A severance package can have positive and negative impacts on your retirement goals. These impacts depend on the specific terms of the package and how you choose to use the funds.

On the positive side, if the severance package includes a lump sum payment, you could use that money to increase your retirement savings. For instance, you could use it to contribute to an Individual Retirement Account (IRA), 401(k), or other retirement plans. If the package includes a retirement plan and stock options, it could take you one step closer to your retirement goals.

On the negative side, if you use the severance pay to cover immediate expenses and don’t save or invest the money, it may not significantly impact your retirement goals. Additionally, losing certain benefits like retirement plans and stock options may set back your retirement goals.

It’s essential to consider the potential impact of a severance package on your retirement goals. You might consult a financial advisor to help evaluate your options and develop a plan.

What if I had a 401(k) with the company?

Stray 401(k) policies are an ever-growing problem for employees. The decision of whether to keep your 401(k) with your former employer or transfer it to another 401(k) or an IRA depends on several factors. These can include the investment options available in the 401(k) plan, the fees associated with the plan, and the terms of the plan.

It is important that when you leave a company, whether it be on your own accord or forced, you don’t forget about all the compensation and retirement plans you own.

While keeping your 401(k) with your former employer may seem like a good idea, it can have consequences. The old adage “out of sight, out of mind” may negatively impact the plan’s overall performance. For instance, you might forget you own the plan or fail to maintain the strategy and investments you’d worked out for it. 

On the other hand, rolling over your 401(k) to an IRA can provide you with more investment options and potentially lower fees. IRAs also offer more flexibility, allowing you to choose from a wide range of investment options, such as stocks, bonds, and mutual funds.

Another thing to consider is whether you’re still vested in your 401(k) plan. If you leave the company before the vesting schedule is completed, you will lose some or all of the employer’s contributions.

If you’re considering rolling over your 401(k) to an IRA, it may be a good idea to consult a financial advisor or tax professional to discuss your options. This can help ensure the rollover process is done correctly and within the legal time limits to avoid any taxes and penalties.

Whether to keep your 401(k) with your former employer or transfer it to an IRA will depend on your situation. The best option for you may be to explore both options before deciding.

What about my profit sharing plan?

For those on a profit-sharing plan or who own shares in the company, it’s essential to consider the potential impact on your financial situation and investment portfolio. Here are some steps that you may want to consider:

  1. Review your employment contract or company stock plan: Make sure you understand the terms of your employment contract or company stock plan and any restrictions on selling your shares.
  2. Assess the value of your shares: Evaluate the current value of your shares and the potential impact on your overall investment portfolio.
  3. Consider your options: If you are still vested in the shares, you may have the opportunity to keep them or sell them. You may be required to sell the shares if you are no longer vested.
  4. Seek professional advice: If you are uncertain about your options or the tax implications of selling your shares, it is a good idea to consult with a financial advisor or tax professional.
  5. Make a decision: Based on your assessment of the value of your shares, your overall financial situation, and the advice of professionals, decide whether to keep or sell your shares.

As with a 401(k), vesting schedules play a crucial role in company stock and profit-sharing accounts. Before making any decisions, you should always consider the potential impact on your financial situation and investment portfolio.

What if my company doesn’t offer me a severance package?

Employment laws don’t require severance packages. The Department of Labor states clearly and explicitly that “there is no requirement in the Fair Labor Standards Act (FLSA) for severance pay.”

By design, severance packages have many perks that help employees transition to their next endeavor. So, what do you do if you work (or worked) for a company that doesn’t offer a severance? 

Here are a few options you may want to consider:

  1. File for unemployment insurance: If you are eligible, you can file for UI benefits through your state’s unemployment office. These benefits will provide temporary financial assistance while looking for a new job. Even if your company gave you a severance, you might still qualify for some benefits. So, don’t forget about this step.
  2. Look for other benefits: Some companies may offer other forms of compensation, such as outplacement services, a continuation of health insurance, or pay for unused leave.
  3. Consult with a lawyer: If you believe you have been wrongfully terminated or your company has violated any laws or regulations, you may want to consult an employment lawyer for legal advice.
  4. Negotiate with your employer: If your company does not offer a formal severance package, you may be able to negotiate for one. This could include a lump sum payment or a period of salary continuation.
  5. Review your contract or company policy: These should outline whether you’re entitled to compensation, benefits, or notice upon termination. It’s important to understand your rights and options and to take steps to protect your financial well-being after losing your job.

How do I file for unemployment?

The above tips are a great place to start if your employer has severed the relationship. However, most of those tips fall on the first option of filing for unemployment insurance. Much like medicare tax or social security taxes, you’ve paid into an unemployment fund with each paycheck. So, it is completely reasonable for you to collect from it when you need it.

So, how does one go about filing for unemployment compensation? Consider these steps:

  1. Check eligibility: You must meet specific eligibility requirements to receive UI benefits. These may include earning a minimum wage during a specific period, being unemployed through no fault of your own, and being able and available to work.
  2. Gather required information: To file a claim, you must provide certain information. This might include your personal contact information, Social Security number, and employment history. You may also need to provide information about your last employer, such as their name, address, and phone number.
  3. File a claim: You can file a claim for UI benefits online, by phone, or in person. Each state has different procedures and methods of filing, so check your state’s Department of Labor website for instructions and details.
  4. Provide documentation: You may be required to provide documentation, such as proof of your income, to support your claim. Some states might also require that you register for work or participate in re-employment services.
  5. Wait for a determination: After you file your claim, your state’s unemployment office will review it and determine your eligibility for benefits. You will receive a notice of the determination explaining the decision and any next steps.
  6. Continue to certify for benefits: Once approved, you will typically need to regularly file a claim or recertify to continue receiving benefits. The most common time period for recertification is every two weeks.

How do I find out my state’s process for filing for unemployment?

The process and requirements for filing for UI can vary depending on your state. Check your state’s Department of Labor website for specific details and instructions. Here are a few ways to find contact information for your state’s unemployment office:

  1. Search online: You can search for your state’s unemployment office by searching for “unemployment insurance” or “unemployment benefits” along with the name of your state. The state’s Department of Labor website usually has a section for unemployment insurance.
  2. Call your state’s labor department: You can find the phone number for your state’s labor department by searching online or looking in the state government section of the phone book.
  3. Visit your state’s labor department: Some states have physical offices where you can file a claim in person. You can find the address of your state’s labor department by searching online or looking in the state government section of the phone book.

Will my retirement suffer if I receive unemployment?

For you super saver money personalities, this is good news for you.

If you stay committed to your retirement plans, you can still contribute to retirement accounts while receiving UI benefits. The money you receive from unemployment is considered taxable income. Therefore, you can use it to save for retirement, just like your regular income.

There are several types of retirement accounts that you may be able to contribute to, such as:

  • Traditional or Roth IRAs: These accounts allow you to save for retirement with pre-tax or after-tax dollars, respectively. You can contribute up to $6,000 for 2022. If you’re over 50, you can contribute up to $7,000.
  • 401(k), 403(b), or other employer-sponsored plans: If you are employed and your employer offers a retirement plan, you can participate in it while you receive unemployment. You can contribute a percentage of your salary to the plan up to a certain limit.
  • Health Savings Account (HSA): If you have a high-deductible health plan, you may be able to contribute to an HSA, which can be used to pay for qualified medical expenses.

Contributions to these accounts have limits. Consider checking the annual contribution limits for the account you’re interested in before making any contributions. It’s also important to consult with a financial advisor or tax professional before making any contributions. They can help ensure that it fits your overall financial plan.

Whether you receive a severance package or unemployment insurance, understand that changing a job abruptly can be very difficult. Know that plenty of resources are available to help you get through this process.